On Wednesday, Telefonica's O2 (Slough, England) announced plans to introduce free calls to mobiles and landlines over the internet. This decision highlights a key challenge for mobile operators - overcoming the commoditization of voice calls - a process which is being facilitated by falling mobile termination rates. Offering their own applications will be one way for operators to differentiate their products and retain a share of this growing market.

The Financial Times reported that Telefonica will trial an internet-calling product called 'O2 Connect' in the UK, which may become a commercial service in 2012. O2 Connect will initially be a downloadable application available on Apple and Android smartphones. The application could potentially allow a Skype-type account - and phone number - to be accessed from a number of devices.

"A key barrier to free voice at present is mobile termination rates which remain high compared to land line rates," says Damien Chew, senior director of the TMT team at Fitch Ratings in London. "However, regulatory pressure has and will continue to drive these rates down. The lower they go, the more attractive free voice as a loss leader becomes to a variety of market players, beyond just internet call companies. This will translate into more downward pressure on voice prices."

The potential danger of this development for the operators is that they could become utility-like, providing undifferentiated data-only tariffs subject to intense price competition, with profit being siphoned off by application providers. However, mobile operators could combat this by using their knowledge of their networks - and possibly their ability to manage data flows through these applications - to claim a share of the application revenues to reinforce both profits and brand image.

Overall, Fitch Ratings expects no negative revenue implications for O2 from the move. The product, if successful, could be a significant brand differentiator, attracting customers to O2's data offering rather than competitors'. Any potential negative price implications will be further mitigated by the widespread practice of bundling voice, SMS and data for the UK's post-paid customers.

This application has network implications also, in that it could allow calls to be routed through WiFi connections rather than through mobile networks. This, if competitors follow suit, may remove one of the few remaining differentiators between networks - domestic signal coverage.